Question

Consider the following​ statement: ​"The Fed has an easy job. Say it wants to increase real GDP by​ $200 billion. All it has to do is increase the money supply by that​ amount." The statement is ▼ correct incorrect because an increase in the money supply ▼ does does not affect real GDP directly.

Answer 1

The statement is incorrect

Step-by-step explanation:

As the statement correctly describes, the money supply does not directly affect real GDP, what it affects directly is the interest rate, and the inflation rate, which are monetary variables, while GDP is a variable that measures output.

When the Fed increases the money supply, it may be doing so with the hope of stimulating economic activity, and thus, increasing GDP, but the Fed knows that any effect will be indirect. What will happen under this expansionary monetary policy is that the interest rate will fall, and as it falls, the supply of loans will grow, investment will become cheaper, and more investment means more factors of production, or more productivity, which in turn, increase the real GDP, but as it can be seen, the effect is indirect.

In fact, if the FED goes overboard with increasing the money supply, it may cause high inflation or even hyperinflation, and these events actually lead to less investment, less saving, and less economic activity, resulting in a probable stagnation or contraction of GDP.